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Mercury News Interview: Joseph A. Grundfest, Stanford Law Professor

Professor Joseph Grundfest, co-director of the annual Directors’ College, talks to Scott Duke Harris of The Mercury News about the political and regulatory climate for American corporations:

An appointment to a board of directors in corporate America once represented a career milestone with no obvious downside. For a little light lifting, typically involving a rubber stamp, directors enjoyed extra compensation, perks and prestige.

But in the 1990s, the risks became greater and the work harder as plaintiffs' attorneys and shareholder activists began holding corporate officers accountable for their decisions. In 1995, Stanford Law School inaugurated its Directors' College, an annual two-day crash course to help corporate officers better understand their legal and ethical responsibilities.

Professor Joseph A. Grundfest has played a leading role in Directors' College from it inception. The 225 participants in the 2010 Directors' College, which ends today, heard from such speakers as Mary Schapiro, new chairman of the Securities and Exchange Commission and Oracle President Safra Catz.

Grundfest, himself a former SEC commissioner, recently shared his perspective on the political and regulatory climate for American corporations. The following has been edited for length and clarity.

Q A Nexis search of the phrase "corporate governance" in major U.S. newspapers over the past two decades found 84 such stories in both 1990 and '91, then between 200 and 400 from 1995 to 2001, to more than 2,700 in both 2002 and 2003, before settling in the 600s in 2008 and 2009. Why have corporate boards come under so much more scrutiny?

A Crises and meltdowns. The Enron and WorldCom frauds were shocks to the governance system. Congress reacted by adopting the Sarbanes Oxley Act of 2002, and many institutional investors became more active in the governance process. They campaigned for a wide variety of governance reforms, including the right of shareholders to place their own nominees for the board directly on the corporate proxy. That proposal, widely known as "proxy access," is today the subject of sharp horse-trading up on Capitol Hill where lawmakers are attempting to hammer out financial reform legislation that may also include a range of corporate governance reforms.

Q Before its scandalous demise, Enron had close political ties to President George W. Bush, helping to shape federal energy policy even while gaming the California electricity market. Late in the Bush administration came the financial industry meltdown and the discovery of Bernie Madoff's epic Ponzi scheme. As someone who served on the SEC under the first President Bush, how do you assess the SEC's performance over the past decade?

A Well, it wasn't the best of decades for the SEC. The failure to nab Madoff is, I suspect, the low point in the agency's history. As Madoff himself has explained, all the commission had to do to shut him down was to check whether he was trading with any of the brokers he claimed as his counterparties. A simple phone call would have shut him down, but they never made the call. Just as disappointing is the fact that many staffers simply didn't understand the strategy that Madoff claimed to be following and why his performance claims were, to be polite, implausible. Simply put, the lawyers didn't understand enough about finance to realize that they were dealing with a crook. It was, unfortunately, the SEC's own incompetence that allowed Madoff to thrive.

Q What is your opinion of the idea that the SEC's troubles under Republican leadership were rooted in an ideological belief that free markets thrive with minimal government intervention?

A I am happy to blame both parties with equal vigor. Both parties supported housing market policies that sank our economy, and both parties opposed various forms of regulation could have been efficiently adopted. President Obama hit the right note when he observed that the question isn't more regulation or less regulation: The question is smarter regulation.

As we speak, the House and Senate conferees are arm wrestling over a broad set of corporate governance reforms, and it is extremely difficult to predict the outcome of these behind-the-scenes horse-trading sessions. At a minimum, I expect to see some form of "say on pay" legislation that will provide for shareholder referendums on executive compensation. This is serious sausage making going on behind the scenes.

Q Some political observers suggest that the anti-incumbent mood arising from the bailout of the financial industry could extend to corporate boards. What do you think?

A I think there is much merit to that view. People are mad. Very mad. And understandably so. Unemployment remains high. Dreams of economic security have been shattered. There is broad concern over the deficit and future tax burdens. Meanwhile, BP's offshore rig explodes, Massey's coal mine collapses, and Toyota's cars accelerate inexplicably. I would be surprised if some of this anger wasn't directed at corporations and at their boards.

Q What are some pressing concerns for attendees to this years Directors' College? What might be keeping Silicon Valley corporate officers awake at night?

A First, risk management. How do we intelligently run our business so that we don't wind up on the front page of the Merc for all the wrong reasons? Here in Silicon Valley, protecting consumer privacy on the software side is a front-and-center issue. Second, executive compensation. How can we appropriately compensate our executives without raising the ire of our shareholder base?